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If you thought this was interesting, you ain't seen nothing yet. This was just the preamble, I have a whole list of banks, each with a story more ludicrous than the last, each still taking deposits, and yes.... for the US centric Americans, with operations in the US and securities trading on our exchanges. Paying subscribers (at this point, I don't see why most of you aren't paying, you'll let these banks take your money for .7% interest, but you won't pay a few dollars for a hardcore educational analysis???) can access the first of these banks right now - EU Bank Capital Confusion, Potential Failure. You may click here to subscribe...

It is my opinion that banks worldwide are simply not safe anymore, and we are on the precipice of a banking crisis that will make the Lehman fiasco look like a test run. For one, interest rates will definitely have to rise. Yes, I know Bernanke is running ZIRP, the ECB is QE to infinity and beyond, yada, yada... But these entities are not the end all and be all for market rates. They can manipulate rates, but they can't ultimately control them for the long term. After 6 years, it's been long term... With banks failing and taking depositor's and bondholder's funds with them, there's simply not enough people stupid enough to accept .7% returns in exchange for the very likely possibility of losing a large chunk of (the majority of, or possibly all of) their principal to go around!!! This central bank Ponzi scheme of printing more money to pay for the debt that you couldn't afford to pay back because you didn't have the money relies on the "Greater Fool Theory". Common sense dictates that this theory is predicated on an ample supply of "Greater Fools". What you will read below should shake the foundations of your belief in the EU banking system, and hopefully will start a dearth in "Greater Fools"! Even more alarming, it actually gets worse from here. Oh yeah, if you have believe that the information below actually identifies a gross misrepresentation of fact, omission or outright fraud, simply contact the SEC and let them know that Reggie Middleton suggested they look into it. You can actually use this form to convery my message.

First Off Let's Make Bank Collapse Real...

To begin with, let's make this Cyprus thing real, by showing a live example of what happens when to a real small business that had the gall to bank with Laikie Bank, from the Bitcoin forum I excerpt a post that puts things into perspective, re: bank account confiscation:

Most of the circulating assets on our business Current Account are blocked. Over 700k of expropriated money will be used to repay country's debt. Probably we will get back about 20% of this amount in 6-7 years.I'm not Russian oligarch, but just European medium size IT business. Thousands of other companies around Cyprus have the same situation.The business is definitely ruined, all Cypriot workers to be fired.We are moving to small Caribbean country where authorities have more respect to people's assets. Also we are thinking about using Bitcoin to pay wages and for payments between our partners.Special thanks to:- Jeroen Dijsselbloem- Angela Merkel- Manuel Barroso- the rest of officials of "European Comission"

Next, Let's Realize That Cyprus Is Not A "Special Case", It Is Like The Template For Future Actions

Just the fear of another wave of bank collapse has government officials and regulators in fear. Why are they afraid? I made the cause of such fear clear to all at the ING Valuation Conference in Amsterdam.

The Farce!

The government has set up an asset management agency – NAMA, which will buy toxic assets from banks at a discount and will in turn issue government-guaranteed securities. NAMA was expected to buy about $81 billion of toxic assets at a price of $43 billion and issue government-guaranteed securities in return. Since these securities have collateral backing and are likely to be repaid through the pay back of underlying loans, these securities are considered off-balance-sheet and are not part of general government debt by Eurostat. According to Davy research, while the projected gross government debt excluding the impact of promissory notes and NAMA bonds is 84.8% in 2012, including the impact of promissory notes and NAMA bonds (in other words, including the truth), the gross government debt can rise to 117.4% of GDP. This either competes with or bests Greece, 2010's poster child of flagrant spending.

This means that the teacher has created a very harsh austerity plan for its "learner"/student/tax paying populace that has materially lowered the standard of living - all based upon numbers that were bogus to begin with. In other words, it ain't gonna work!

Well, today we have proof and that proof will likely leave some EU bank despositors "Cyprus'd", and I don't mean just those in Cyprus either.

Introduction and Background

In 2007 Ireland had significant cross border exposure to UK and US banks through derivatives and property products. As I warned in 2007, the real estate bubble in the the US/UK popped in 2008, sending pathogenic contagion straight through the Irish banking system. The entire banking system started collapsing. On February 15, 2008, Ireland took extraordinary measures (which we will explore in depth a little later on) to mitigate said collapse, measures that many a layperson would deem misleading, if not fraudulent. RBS (Royal Bank of Scotland, one of the largest financial institutions in the countries of Ireland and the UK) was effectively nationalized by the UK and a bad bank was formed to purchase bad debt/products from the Zombie Irish banks in exchange for government bonds, backed by a country that just simply couldn't afford it.

Following my warning in February of 2008, Lehman filed bankruptcy in September sending an additional set of contagion shock through Ireland and its banking system, causing Ireland to issues bonds and further indebt itself to save its Zombie banks – again! This time through blanket bank guarantees backed by the full faith of the government.

In September of 2010, a large swath of said government guarantees for the banks were about to expire. Reference this excerpt from the book “Zombie Banks: How Broken Banks and Debtor Nations Are Crippling the Global Economy”:

In September 2010, some of Ireland's government guarantees for bank debts were about to expire, which put U.S. Treasury officials on edge. If the guarantee wasn't renewed, the banks would likely default on their bonds, triggering the next event in line: a slew of credit default swap (CDS) contracts on Irish banks' debt. U.S. Treasury officials had reason to worry - the names backing those contracts were the largest U .S. banks, and they could end up paying billions in case of default. Any more weight on U.S. banks could be a tipping point to collapse. Treasury officials made inquiries to their counterparts at the Irish finance ministry asking about the course of action the country was planning to take and indicated their concern about possible default and its CDS repercussions. A year after having issued blanket guarantees on the banks' liabilities the Irish government once again didn't dare let the bank fail. Instead it ended up asking for financial assistance from the European Union (EU) and the International Monetary Fund (IIMF): the country had been pushed to the brink of collapse.

The next few posts will document details the financial shenanigans played by several EU banks (Ireland included), among others, to the tune of over €40 billion. This money was essentially double counted, or to put more simply, at least one version of it simply doesn't exist on someone’s balance sheet.

I have compiled a list of at least 6 banks which I feel are at risk of being Cyprus'd, with more being added weekly. The first bank report, whose subject is still steadily accepting deposits at measly interest rates, is available for download right now for all paying BoomBustBlog subscribers (click here to subscribe), reference EU Bank Capital Confusion, Potential Failure. Those of you who actually follow this banking stuff may very well be shocked at how bold the actions described therein actually are!

For now, let’s focus on Ireland and the Irish banks.

Anglo Irish Bank

Anglo Irish Bank which subsequently became Irish Bank Resolution Corporation (IBRC), was recently liquidated by the Irish Government. Included below are three documents executed by this bank. The first two are charge documents that the bank entered into on the 15th of February, 2008. These charges are in favor of the Central Bank and Financial Services Authority of Ireland (the ECB). They are floating charges over Secured Obligations (repo agreements) and the banks payment module account.

So, What's So Special About These Documents???

The reasons given for the floating charges are the banks participation in Target 2, which is a interbank, cross-border EU real-time payment system. A former Group Chief Auditor of one of Ireland’s largest banks who was part of the team who conducted the stress testing for the European Banking Authority was allegedly quite shocked to see the various charge documents herein. He informed BoomBustBlog consultants that these charge documents were not included in the stress testing. For those who don’t get the gravity of this statement – the previous encumbering of the Irish bank’s assets were ignored or not known by those who conducted the stress testing for the banks. What makes things even worse was despite the fact the bank’s assets were double counted, allowing them to pass the stress tests, they promptly started failing post stress test… And I do mean promptly, as in within months.

The chief auditor was also allegedly able to inform that the reasons given for the purpose of the charges was a red herring. He allegedly advised that Target 2 is only a payment system and the description stated was a complete misrepresentation of the true reasons.

The real reasons for the charges were because the bank was completely bust. The bank had already previously entered into repo transactions (secured obligations) with the Irish Central Bank (ECB) and had run out of money. The Irish Central Bank gave further funding using these charge documents. The share price of Anglo in February 2008 was still quite high but started to collapse over the coming months. These charge documents are not disclosed in the Annual Accounts (the EU version of an annual report) for the 31st of March, 2008.

Questions also arise as to the validity of the asset transfer, the legality of Anglo Irish Bank and/or the ECB entering into repo agreements, and the activity of Anglo Irish Bank in regards to its trading activity… If a charge was given over ALL of Anglo Irish's assets, then exactly how did it legally engage in the MBS, derivative and trading activity? Underlying assets must be pledged to a trust in order to create many derivative structures, including MBS, but if there's a negative pledge clause in the charge and the charge covers nearly everything, then those assets don't truly belong to said trust, do they? You can imagine how far one can go with this line of thinking, no?

If you were an investor, shareholder, bondholder or regulator the information above was critical information - EXTREMELY CRITICAL INFORMATION! Anglo ADR's were also traded through brokers in the USA. I am sure that ADR holders would have liked to have been aware of this information, as well as the SEC.

I see a number of avenues which could be worth pursuing, including terms of recompense for junior bondholders who got hosed, equity shareholders who lost capital, counterparties, etc. This is, to my lay ears, tantamount to blatant fraud. Of course, I’m not an international banking lawyer, so what do I know??? Yet, I have only touched on some of the issues. There’s a lot more to come.

In relation to Anglo Irish Bank (IBRC), the 2008 charge document states that the charge covers ‘all present and future liabilities whatsoever of the company, to the Central Bank of Ireland (ECB).’ But there is no disclosure of this in the Anglo 2008 accounts (annual report). This appears to illustrate concealment of the true facts. If these charge documents have not been overridden, then a massive amount of assets in the bank have been over-encumbered. Even if the charges have been overridden in some form or fashion, the mere omission of their existence is a misrepresentation of the banks financial condition, particularly in the stress testing of the banks and regulatory financial reporting (ex. SEC).

If you believe that the information above actually identifies a gross misrepresentation of fact, omission or outright fraud, simply contact the SEC and let them know that Reggie Middleton suggested they look into it. You can actually use this form to convey my message.

As a reminder for those who wish to ignore my banking calls as a frivolous episode of Chicken Little, BoomBustBlog is the place that was the first to reveal:

The collapse of Bear Stearns in January 2008 (2 months before Bear Stearns fell, while trading in the $100s and still had buy ratings and investment grade AA or better from the ratings agencies): Is this the Breaking of the Bear?

The warning of Lehman Brothers before anyone had a clue!!! (February through May 2008): Is Lehman really a lemming in disguise? Thursday, February 21st, 2008 | Web chatter on Lehman Brothers Sunday, March 16th, 2008 (It would appear that Lehman’s hedges are paying off for them. The have the most CMBS and RMBS as a percent of tangible equity on the street following BSC.

The ENTIRE Pan-European Sovereign Debt Crisis (potentially soon to be the Global Sovereign Debt Crisis) starting in January of 2009 and explicit detail as of January 2010: The Pan-European Sovereign Debt Crisis

The Banks Are Bigger Than Many of the Sovereigns

Definitions:

Charge

The document evidencing mortgagesecurity required by Crown Law (law derived from English law). A Fixed Charge refers to a defined set of assets and is usually registered. A Floating Charge refers to other assets which change from time to time (ie. cash, inventory, etc.), which become a Fixed Charge after a default.

Repurchase Agreement

A repurchase agreement, also known as a repo, RP, or sale and repurchase agreement, is the sale of securities together with an agreement for the seller to buy back the securities at a later date. The repurchase price should be greater than the original sale price, the difference effectively representing interest, sometimes called the repo rate. The party that originally buys the securities effectively acts as a lender. The original seller is effectively acting as aborrower, using their security as collateral for a secured cash loan at a fixed rate of interest.

A repo is equivalent to a spot sale combined with a forward contract. The spot sale results in transfer of money to the borrower in exchange for legal transfer of the security to the lender, while the forward contract ensures repayment of the loan to the lender and return of the collateral of the borrower. The difference between the forward price and the spot price is effectively the interest on the loan, while the settlement date of the forward contract is the maturity date of the loan.

Target 2

TARGET 2 is an interbank payment system for the real-time processing of cross-border transfers throughout the European Union. TARGET2 replaced TARGET (Trans-European Automated Real-time Gross Settlement Express Transfer System) in November 2007.

Next up is a bank that is still steadily accepting deposits at a steady clip, paying ungodly low interest rates, and setting itself up to potentially get "Cyprus'd". Paying subscribers can download the report now, before capital controls are set in - see EU Bank Capital Confusion, Potential Failure. Everybody else can subscribe or wait until either I make it public or the respective government does the Cyprus Thang! Yes it pays to be a BoomBustBlog member (click here to subscribe).

I will start posting a list of definitive bank names that I have apparently caught in some amazingly duplicitous and misleading capital schemes, at least as it appears to me and my staff. I know I wouldn't have MY money in them, particularly after reading the info above.

Continuing my series of banks ready to "Cyprus" their depositors, I offer this reader contribution from Don from Canada 2013-03-29 23:11:

As part of the 2013 budget in Canada, the Minister of Finance tabled the Economic Action Plan 2013 which included the newest buzzword 'bail-in'.

Source: budget.gc.ca/.../...Page 145“The [Canadian] Government proposes to implement a “bail-in” regime for systemically important banks. This regime will be designed to ensure that, in the unlikely event that a systemically important bank depletes its capital, the bank can be recapitalized and returned to viability through the very rapid conversion of certain bank liabilities into regulatory capital. This will reduce risks for taxpayers. The Government will consult stakeholders on how best to implement a bail-in regime in Canada. Implementation timelines will allow for a smooth transition for affected institutions, investors and other market participants. Systemically important banks will continue to be subject to existing risk management requirements, including enhanced supervision and recovery and resolution plans.This risk management framework will limit the unfair advantage that could be gained by Canada’s systemically important banks through the mistaken belief by investors and other market participants that these institutions are ‘too big to fail’.”

A depositor is an unsecured creditor to a bank. The Canadian government presents its position to be one of shielding the taxpayer from the need to pay for bailing out a failing bank. As a taxpayer that is comforting. However as a depositor, the phrase “rapid conversion of certain bank liabilities into regulatory capital” concerns me. My deposit is the bank’s liability. Could depositors’ funds fall under the definition of ‘certain bank liabilities’? I searched the entire 442 page document and I cannot find where the term ‘certain bank liabilities’ is defined.The prudent approach I believe would be to assume that under certain conditions, certain bank liabilities will include depositors’ funds; at least those funds in excess of CAD 100,000 which is our so-called insured amount.Even if it has noble intentions now, under a credit and derivatives collapse scenario, it is conceivable that the Canadian government could be coerced or bullied by external agents into grabbing depositors’ funds just like what is happening in Cyprus.I find the newest ‘bail-in’ term being used since the Cyprus debacle quite amusing. It reminds me of the ‘sit-in’ and ‘love-in’ terms of the peace/hippie generation.We all seem to be floating on the bathwater of fiat currency liquidity. The tub is being drained at the opposite end from where we are floating. The EU is circling the drain. The central banks are feverishly trying to replenish the tub with thimbles full of water, but it appears inevitable that some will go down the drain, whilst others will be left high and dry. The central bankers only have thimbles, not a drain stopper.

Now, tell me if this looks even remotely familiar... from an article publsihed in the Financial Times on February 10, 2013 which clearly, accurately and timely foretold the events to unfold over the following 45 days or so :

A radical new option for the financial rescue of Cyprus would force losses on uninsured depositors in Cypriot banks, as well as investors in the country’s sovereign bonds, according to a confidential memorandum prepared ahead of Monday’s meeting of eurozone finance ministers.

The proposal for a “bail-in” of investors and depositors, and drastic shrinking of the Cypriot banking sector, is one of three options put forward as alternatives to a full-scale bailout. The ministers are trying to agree a rescue plan by March, to follow the presidential elections in Cyprus later this month.

By “bailing in” uninsured bank depositors, it would also involve more foreign investors, especially from Russia, some of whom have used Cyprus as a tax haven in recent years. That would answer criticism from Berlin in particular, where politicians are calling for more drastic action to stop the island being used for money laundering and tax evasion.

Labelled “strictly confidential” and distributed to eurozone officials last week, the memo says the radical version of the plan – including a “haircut” of 50 per cent on sovereign bonds – would shrink the Cypriot financial sector, now nearly eight times larger than the island’s economy, by about one-third by 2015.

Senior EU officials who have seen the document cautioned that imposing losses on bank depositors and a sovereign debt restructuring remain unlikely. Underlining the dissuasive language in the memo, they said that bailing in depositors was never considered in previous eurozone bailouts because of concern that it could lead to bank runs in other financially fragile countries.

But the authors warn such drastic action could restart contagion in eurozone financial markets...

In what appears to be drastically worse than many had hoped (and expected), uninsured depositor in Cyprus' largest bank stand to get no actual cash back from their initial deposit as the plan (expected to be announced tomorrow) is:

22.5% of the previous cash deposit gone forever (pure haircut)

40% of the previous cash deposit will receive interest (but will never be repaid),

and the remaining 37.5% of the previous cash deposit will be swapped into equity into the bank (a completely worthless bank that is of course.)

So, theoretically this is 62.5% haircut but once everyone decides to 'sell' their shares to reconstitute some cash then we would imagine it will be far greater. Furthermore, at what valuation will the 37.5% equity be allocated (we suspect a rather aggressive mark-up to 'market' clearing levels).

Critically though, there is no cash. None. If you had EUR150,000 in the bank last week (net of insured deposits which may well be impaired before all is said and done) you now have EUR0,000 to draw on! But will earn interest on EUR60,000 (though we do not know at what rate); and own EUR56,250 worth of Bank of Cyprus shares (the same bank that will experience the slow-burn leak of capital controlled outflows).

Now that you see its just Cyprus - the perceived uber-conservative Canadian banks are prepping to Cyprus their depositors as well.

Oh, it gets worse. I will start posting a list of definitive bank names that I have apparently caught in some amazingly duplicitous and misleading capital schemes, at least as it appears to me and my staff. I know I wouldn't have MY money in them, particularly after reading the info above. The first bank name and a description of their actions are avialable to all paying subscribers right now in the right hand downloads column and in the commercial bank research section of my site. I will release a new bank expected to be "Cyprus'd" every 48 hours to subscribers until I run out of definitive candidates. Yes it pays to be a BoomBustBlog member (click here to subscribe).

This Easter weekend, I will also release a PSA (public service announcement) to give a heads up to non-paying subscribers and readers who are too comfortable with their current banking arrangement.

As a reminder for those who wish to ignore my banking calls as a frivolous episode of Chicken Little, BoomBustBlog is the place that was the first to reveal:

The collapse of Bear Stearns in January 2008 (2 months before Bear Stearns fell, while trading in the $100s and still had buy ratings and investment grade AA or better from the ratings agencies): Is this the Breaking of the Bear?

The warning of Lehman Brothers before anyone had a clue!!! (February through May 2008): Is Lehman really a lemming in disguise? Thursday, February 21st, 2008 | Web chatter on Lehman Brothers Sunday, March 16th, 2008 (It would appear that Lehman’s hedges are paying off for them. The have the most CMBS and RMBS as a percent of tangible equity on the street following BSC.

The ENTIRE Pan-European Sovereign Debt Crisis (potentially soon to be the Global Sovereign Debt Crisis) starting in January of 2009 and explicit detail as of January 2010: The Pan-European Sovereign Debt Crisis

Maurice Greenberg, the ousted CEO, Chairman, and founder of AIG who remains a major investor in the company, filed suit in 2011 on behalf of fellow shareholders against the government. He has urged A.I.G. to enjoin which should pressure the government into settlement talks - that is if the powers that be don't start distending the law. NY Times Dealbook looks at it this way:

Should Mr. Greenberg snare a major settlement without A.I.G., the company could face additional lawsuits from other shareholders. Suing the government would not only placate the 87-year-old former chief, but would put A.I.G. in line for a potential payout.

Yet such a move would almost certainly be widely seen as an audacious display of ingratitude. The action would also threaten to inflame tensions in Washington, where the company has become a byword for excessive risk-taking on Wall Street.

Some government officials are already upset with the company for even seriously entertaining the lawsuit, people briefed on the matter said. The people, who spoke on the condition of anonymity, noted that without the bailout, A.I.G. shareholders would have fared far worse in bankruptcy.

“On the one hand, from a corporate governance perspective, it appears they’re being extra cautious and careful,” said Frank Partnoy, a former banker who is now a professor of law and finance at the University of San Diego School of Law. “On the other hand, it’s a slap in the face to the taxpayer and the government.”

AIG has every right and responsibility to sue the US for excessive interest payments on it's bailout! Yes, the company failed in execution. Yes, the company would have went bust if the government didn't rescue it. But that is besides the point. If the government wanted market forces to reign supreme they would have let AIG collapse. The fact is they didn't. The reason is because the government was bailing out the banks, namely the most politically connected publicly traded entity in the entire world. The Vampire Squid! Goldman Sachs! As excerpted from the NY Times:

At the end of the American International Group’s annual meeting last month, a shareholder approached the microphone with a question for Robert Benmosche, the insurer’s chief executive. “I’d like to know, what does A.I.G. plan to do with Goldman Sachs?” he asked. “Are you going to get — recoup — some of our money that was given to them?

As a condition of AIG's bailout, the government "insisted" on paying Goldman et. al. 100 cents on the dollar of its CDS written with AIG, something that wouldn't have been necessary if Goldman had prudently underwritten counterparty and credit risks that it was taking. Apparently, the US government believes that it didn't. In addition, it's somethng that wouldn't have been possible if the government didn't intervene on behalf of the banks, forcing the AIG shareholders to take a hit, but shielding the Goldman, et. al. shareholders. As my grandma used to tell me, what's good for the goose is good for the gander! It's not as if these credit/counterparty risks were invisible, I saw them as far back as early 2008 - reference I won't say I told you so, again. This page also happened to of shown the credit risk concentration of every bank granted a reprieve by the government after the fact. As a matter of fact, there's still more than a modicum of risk present, as clearly illustrated in...

Hunting the Squid, Part2: Since When Is Enough Derivative Exposure To Blow Up The World Something To Be Ignored?

Welcome to part two of my series on Hunting the Squid, the overvaluation and under-appreciation of the risks that is Goldman Sachs. Since this highly analytical, but poignant diatribe covers a lot of material, it's imperative that those who have not done so review part 1 of this series, I'm Hunting Big Game Today:The Squid On The Spear Tip, Part...

Hunting the Squid, part 4: So, What Else Can Go Wrong With The Squid? Plenty!!!

Yes, this more of the hardest hitting investment banking research available focusing on Goldman Sachs (the Squid), but before you go on, be sure you have read parts 1.2. and 3: I'm Hunting Big Game Today:The Squid On A Spear Tip, Part 1 & Introduction Hunting the Squid, Part2: Since When Is Enough Derivative Exposure To Blow Up The World Something To...

Now, AIG's shareholders are being forced to finance the bailout of Goldman Sachs. To not combat that should open AIG management up to shareholder lawsuits, for they are not acting as a fiduciary of the shareholder capital if they let this slide. It's one thing to pay for the AIG bailout, but its another to pay for the Goldman bailout. In addition, this forced bailout that refused to force AIG creditors not to take haircuts runs counter to the ideology the government used when it forced the Chrysler's creditor's to take massive haircuts.

When the government began rescuing it from collapse in the fall of 2008 with what has become a $182 billion lifeline, A.I.G. was required to forfeit its right to sue several banks — including Goldman, Société Générale, Deutsche Bank and Merrill Lynch — over any irregularities with most of the mortgage securities it insured in the precrisis years.

... documents also indicate that regulators ignored recommendations from their own advisers to force the banks to accept losses on their A.I.G. deals and instead paid the banks in full for the contracts. That decision, say critics of the A.I.G. bailout, has cost taxpayers billions of extra dollars in payments to the banks. It also contrasts with the hard line the White House took in 2009 when it forced Chrysler’s lenders to take losses when the government bailed out the auto giant.

Regulatory capture! Banks simply lobby harder and pay more to the government than auto companies. How many auto company execs are embedded in government leadership seats worldwide?

As a Congressional commission convenes hearings Wednesday exploring the A.I.G. bailout and Goldman’s relationship with the insurer, analysts say that the documents suggest that regulators were overly punitive toward A.I.G. and overly forgiving of banks during the bailout — signified, they say, by the fact that the legal waiver undermined A.I.G. and its shareholders’ ability to recover damages.

“Even if it turns out that it would be a hard suit to win, just the gesture of requiring A.I.G. to scrap its ability to sue is outrageous,” said David Skeel, a law professor at the University of Pennsylvania. “The defense may be that the banking system was in trouble, and we couldn’t afford to destabilize it anymore, but that just strikes me as really going overboard.”

“This really suggests they had myopia and they were looking at it entirely through the perspective of the banks,” Mr. Skeel said.

Nahh? It's called the Federal Reserve Bank, not the Federal Reserve Insurer, nor the Federal Reserve Taxpayer! Who the hell do you think they will back in a crunch?

About $46 billion of the taxpayer money in the A.I.G. bailout was used to pay to mortgage trading partners like Goldman and Société Générale, a French bank, to make good on their claims. The banks are not expected to return any of that money, leading the Congressional Research Service to say in March that much of the taxpayer money ultimately bailed out the banks, not A.I.G.

Of which the interest of about 50% of which should be refunded to AIG shareholders. Without the AIG bailout, these banks would have recieved ZILCH, NOTHING, NADA, Bull Sh1t!

While perusing the news today, I came across this most interesting article in Bloomberg, Swaps ‘Armageddon’ Lingers as New Rules Concentrate Risk'. Before we delve into it, I want to review how vehemently I've sounded the alarm on this topic over the last 6 years. Let's start with So, When Does 3+5=4? When You Aggregate A Bunch Of Risky Banks & Then Pretend That You Didn't?, where I've aggregated my warnings into a single article. In a nutshell, 5 banks bear 96% of the global derivatives risk. The argument to defend such ass backwards risk concentration is "but it's mostly hedged, offset and netted out". Right! You know that old trader's saying about liquidity? It's always available, that is until you need it!

Even though I've made this point of netting = nonsense multiple times, I must admit, ZH did a more loquacious job, as follows:

..Wrong. The problem with bilateral netting is that it is based on one massively flawed assumption, namely that in an orderly collapse all derivative contracts will be honored by the issuing bank (in this case the company that has sold the protection, and which the buyer of protection hopes will offset the protection it in turn has sold). The best example of how the flaw behind bilateral netting almost destroyed the system is AIG: the insurance company was hours away from making trillions of derivative contracts worthless if it were to implode, leaving all those who had bought protection from the firm worthless, a contingency only Goldman hedged by buying protection on AIG. And while the argument can further be extended that in bankruptcy a perfectly netted bankrupt entity would make someone else who on claims they have written, this is not true, as the bankrupt estate will pursue 100 cent recovery on its claims even under Chapter 11, while claims the estate had written end up as General Unsecured Claims which as Lehman has demonstrated will collect 20 cents on the dollar if they are lucky.

The point of this detour being that if any of these four banks fails, the repercussions would be disastrous. And no, Frank Dodd's bank "resolution" provision would do absolutely nothing to prevent an epic systemic collapse.

Cute graphic above, eh? There is plenty of this in the public preview. When considering the staggering level of derivatives employed by JPM, it is frightening to even consider the fact that the quality of JPM's derivative exposure is even worse than Bear Stearns and Lehman‘s derivative portfolio just prior to their fall. Total net derivative exposure rated below BBB and below for JP Morgan currently stands at 35.4% while the same stood at 17.0% for Bear Stearns (February 2008) and 9.2% for Lehman (May 2008). We all know what happened to Bear Stearns and Lehman Brothers, don't we??? I warned all about Bear Stearns (Is this the Breaking of the Bear?: On Sunday, 27 January 2008) and Lehman ("Is Lehman really a lemming in disguise?": On February 20th, 2008) months before their collapse by taking a close, unbiased look at their balance sheet. Both of these companies were rated investment grade at the time, just like "you know who".

So, the Bloomberg article that got this rant started basically says that the risk is being shifted from the banks to clearing houses, who demand above board, translucent collateral for transactions. This should solve the problem, right? Hardly! You see, the Fed and US banking regulators have made it legal and acceptable for banks to outright lie about the qualit of their collateral and the condition of their finances. It all came to light with my research on Lehman (and Bear Stearns, amonst others). These mistakes are so repetitive of the ones made in the past, I literally do not have to right any new material, let's just re-read what was written several years ago:

Let's get something straight right off the bat. We all know there is a certain level of fraud sleight of hand in the financial industry. I have called many banks insolvent in the past. Some have pooh-poohed these proclamations, while others have looked in wonder, saying "How the hell did he know that?"

The list above is a small, relevant sampling of at least dozens of similar calls. Trust me, dear reader, what some may see as divine premonition is nothing of the sort. It is definitely not a sign of superior ability, insider info, or heavenly intellect. I would love to consider myself a hyper-intellectual, but alas, it just ain't so and I'm not going to lie to you. The truth of the matter is I sniffed these incongruencies out because 2+2 never did equal 46, and it probably never will either. An objective look at each and every one of these situations shows that none of them added up. In each case, there was someone (or a lot of people) trying to get you to believe that 2=2=46.xxx. They justified it with theses that they alleged were too complicated for the average man to understand (and in business, if that is true, then it is probably just too complicated to work in the long run as well). They pronounced bold new eras, stating "This time is different", "There is a new math" (as if there was something wrong with the old math), etc. and so on and associated bullshit.

So, the question remains, why is it that a lowly blogger and small time individual investor with a skeleton staff of analysts can uncover systemic risks, frauds and insolvencies at a level that it appears the SEC hasn't even gleaned as of yet? Two words, "Regulatory Capture". You see, and as I reluctantly admitted, it is not that I am so smart, it is that the regulator's goals are not the same as mine. My efforts are designed to ferret out the truth for enlightenment, profit and gain. Regulators' goals are to serve a myriad constituency that does not necessarily have the individual tax payer at the top of the hierarchical pyramid. Before we go on, let me excerpt from a piece that I wrote on the topic at hand so we are all on the same page: How Regulatory Capture Turns Doo Doo Deadly.

You see, the banking industry lobbied the regulators to allow them to lie about the value and quality of their assets and liabilities and just like that, the banking problem was solved. Literally! At least from a equity market pricing and public disinformation campaign point of view...

A picture is worth a thousand words...

fasb_mark_to_market_chart.pngfasb_mark_to_market_chart.png

So, how does this play into today's big headlines in the alternative, grass roots media? Well, on the front page of the Huffington Post and ZeroHedge, we have a damning expose of Lehman Brothers (we told you this in the first quarter of 2008, though), detailing their use of REPO 105 financing to basically lie about theirliquidity positions and solvency. The most damning and most interesting tidbit lies within a more obscure ZeroHedge article that details findings from the recently released Lehman papers, though:

On September 11, JPMorgan executives met to discuss significant valuation problems with securities that Lehman had posted as collateral over the summer. JPMorgan concluded that the collateral was not worth nearly what Lehman had claimed it was worth, and decided to request an additional $5 billion in cash collateral from Lehman that day. The request was communicated in an executive?level phone call, and Lehman posted $5 billion in cash to JPMorgan by the afternoon of Friday, September 12. Around the same time, JPMorgan learned that a security known as Fenway, which Lehman had posted to JPMorgan at a stated value of $3 billion,was actually asset?backed commercial paper credit?enhanced by Lehman (that is, it was Lehman, rather than a third party, that effectively guaranteed principal and interest payments). JPMorgan concluded that Fenway was worth practically nothing as collateral.

Paid subscribers are welcome to download the corporate level valuation of PEI as well as all of the summary stats of our findings on its various properties. The spreadsheet can be found here - Results of Properties Analysis, Valuation of PEI with Lenders' Names. In putting a realistic valuation on PEI, we independently valued a sampling of 27 of its properties. We found that many if not most of those properties were actually underwater. Most of those that weren't underwater were mortgaged under a separate credit facility.

What are the chances that the properties, whole loans and MBS being pledged by PEI's creditors are being pledged at par? Back to the future, it's the same old thing all over again. Like those banks, PEI is trading higher with its public equity despite the fact that its private equity values are clearly underwater - all part of the perks of not having to truly mark assets to market prices.

Clearinghouses cut risk by collecting collateral at the start of each transaction, monitoring daily price moves and making traders put up more cash as losses occur. Traders have to deal through clearing members, typically the biggest banks and brokerages. Unlike privately traded derivatives, prices for cleared trades are set every day and publicly disclosed.

And what happens when everybody lies about said prices? Is PEI's debt really looking any better than GGP's debt of 2007?

GGP Leverage Summary 2007

Properties with negative equity and leverage >80%

32

Properties

with leverage >80%

44

% of properties with negative equity (based on CFAT after debt service)

72.7%

PEI Summary 2012

Both of these companies have debt that have been pledged by banks as collateral. Would you trust either of them? The banks then use the collateral to do other deals leading to more bubbles. What's next up in bubble land? I warned of it in 2009...

The amount of bubbliciousness, overvaluation and risk in the market is outrageous, particularly considering the fact that we haven't even come close to deflating the bubble from earlier this year and last year! Even more alarming is some of the largest banks in the world, and some of the most respected (and disrespected) banks are heavily leveraged into this trade one way or the other. The alleged swap hedges that these guys allegedly have will be put to the test, and put to the test relatively soon. As I have alleged in previous posts (As the markets climb on top of one big, incestuous pool of concentrated risk... ), you cannot truly hedge multi-billion risks in a closed circle of only 4 counterparties, all of whom are in the same businesses taking the same risks.

Click to expand!

bank_ficc_derivative_trading.png

So, How are Banks Entangled in the Mother of All Carry Trades?

Trading revenues for U.S Commercial banks have witnessed robust growth since 4Q08 on back of higher (although of late declining) bid-ask spreads and fewer write-downs on investment portfolios. According to the Office of the Comptroller of the Currency, commercial banks' reported trading revenues rose to a record $5.2 bn in 2Q09, which is extreme (to say the least) compared to $1.6 bn in 2Q08 and average of $802 mn in past 8 quarters.

bank_trading_revenue.png

High dependency on Forex and interest rate contracts

Continued growth in trading revenues on back of growth in overall derivative contracts, (especially for interest rate and foreign exchange contracts) has raised doubt on the sustainability of revenues over hear at the BoomBustBlog analyst lab. According to the Office of the Comptroller of the Currency, notional amount of derivatives contracts of U.S Commercial banks grew at a CAGR of 20.5% to $203 trillion by 2Q-09 from $87.9 trillion in 2004 with interest rate contracts and foreign exchange contracts comprising a substantial 84.5% and 7.5% of total notional value of derivatives, respectively. Interest rate contracts have grown at a CAGR of 20.1% to $171.9 trillion between 4Q-04 to 2Q-09 while Forex contracts have grown at a CAGR of 13.4% to $15.2 trillion between 4Q-04 to 2Q-09.

The need for a Fed rescue isn’t out of the question, said Satyajit Das, a former Citicorp and Merrill Lynch & Co. executive who has written books on derivatives. Das sketched a scenario where a large trader fails to make a margin call. This kindles rumors that a bank handling the trader’s transactions -- a clearing member -- is short on cash.

Remaining clients rush to pull their trading accounts and cash, forcing the lender into bankruptcy. Questions begin to swirl about whether the remaining clearing members can absorb billions in losses, spurring more runs.

“Bank customers panic, and they start to withdraw money,” he said. “The amount of money needed starts to become problematic. None of this is quantifiable in advance.” The collateral put up by traders and default fund sizes are calculated using data that might not hold up, he said.

The collateral varies by product and clearinghouse. At CME, the collateral or “margin” for a 10-year interest-rate swap ranges between 2.89 percent and 4.06 percent of the trade’s notional value, according to Morgan Stanley. At LCH, it’s 3.2 percent to 3.41 percent, the bank said in a November note.

How Much?

The number typically is based on “value-at-risk,” and is calculated to cover the losses a trader might suffer with a 99 percent level of confidence. That means the biggest losses might not be fully covered.

It’s a formula like the one JPMorgan used and botched earlier this year in the so-called London Whale episode, when it miscalculated how much risk its chief investment office was taking and lost at least $6.2 billion on credit-default swaps. Clearinghouses may fall into a similar trap in their margin calculations, the University of Houston’s Pirrong wrote in a research paper in May 2011.

“Levels of margin that appear prudent in normal times may become severely insufficient during periods of market stress,” wrote Pirrong, whose paper was commissioned by an industry trade group.

Using this European bank as a proxy for Bear Stearns in January of 2008, the tall stalk represents the liabilities behind Bear's illiquid level 2 and level 3 assets (including the ill fated mortgage products). Equity is destroyed as the assets leveraged through the use of these liabilities are nearly halved in value, leaving mostly liabilities. The maroon stalk represents the extreme risk displayed in the first chart in this missive, and that is the excessive reliance on very short term liabilities to fund very long term and illiquid assets that have depreciated in price. Wait, there's more!

The modern central banking system has proven resilient enough to fortify banks against depositor runs, as was recently exemplified in the recent depositor runs on UK, Irish, Portuguese and Greek banks – most of which received relatively little fanfare. Where the risk truly lies in today’s fiat/fractional reserve banking system is the run on counterparties. Today’s global fractional reserve bank get’s more financing from institutional counterparties than any other source save its short term depositors. In cases of the perception of extreme risk, these counterparties are prone to pull funding are request overcollateralization for said funding. This is what precipitated the collapse of Bear Stearns and Lehman Brothers, the pulling of liquidity by skittish counterparties, and the excessive capital/collateralization calls by other counterparties. Keep in mind that as some counterparties and/or depositors pull liquidity, covenants are tripped that often demand additional capital/collateral/ liquidity be put up by the remaining counterparties, thus daisy-chaining into a modern day run on the bank!

image006

I'm sure many of you may be asking yourselves, "Well, how likely is this counterparty run to happen today? You know, with the full, unbridled printing press power of the ECB, and all..." Well, don't bet the farm on overconfidence. The risk of a capital haircut for European banks with exposure to sovereign debt of fiscally challenged nations is inevitable.

You see, the risk is all about velocity and confidence. If the market moves gradually, the clearing house system is ok. If it moves violently and all participants move for cash at the same time against bogus collateral... BOOMMMM!!!!!!!

Back to the Bloomberg article...

Stress Levels

What’s more, clearinghouses can’t use their entire hoard of collateral to extinguish a crisis because it’s not a general emergency fund. The sum represents cash posted by investors to cover their own trades and can’t be used to cover defaults of other people.

Clearinghouses can turn to default funds to cover the collapse of the two largest banks or securities firms with which they do business. They have the power to assess the remaining solvent members for billions more, enough to cover the demise of their third- and fourth-largest members.

But wait a minute, the other members are only solvent because they have hedges against the insolvency of the insolvent members. If those hedges fail, then the so-called solvent members are insolvent too! Or did nobody else think of that?

MF Global Holdings Ltd.'s executive in charge of controlling risks raised serious concerns several times last year to directors at the securities firm about the growing bet on European bonds by his boss, Jon S. Corzine, people familiar with the matter said.

The board allowed the company's exposure to troubled European sovereign debt to swell from about $1.5 billion in late 2010 to $6.3 billion shortly before MF Global tumbled into bankruptcy Oct. 31, these people said. The executive who challenged Mr. Corzine resigned in March.

The disagreement shows that concerns about the big bet grew inside the company months ...

As I have hinted in "The Ironic, Prophetic Nature of the MF Global Bankruptcy Filing and It's Potential Ramifications" I knew the ex-CEO of MF Global, and in particular member(s) of in the internal audit staff - one of which I knew very well and trained. There is one glaring FLAW in the structure of internal risk management and audit in MF Global, and that was that it was WEAK! If internal audit answers to operational executive management, then how can it truly crack the whip on its own boss. Now, granted, this is not endemic to just MF Global, but it is truly a problem. Internal audit/risk management needs to answer to a separate entity, apart from the CEO and possibly apart from the Board itself if the CEO has had a part in selecting the board. This way there is true independence and the nonsense that you just saw with MF Global has a much less likely chance of happening.

Alas, such is life. For instance, why are you reading this through a subscription blog versus PWC's audit report of MF Global? Hmmmmmm.....

For anybody who didn't catch the hint, another banking crisis the continuation of the banking crisis is inevitable. I've said it before, Is Another Banking Crisis Inevitable? This is the current landscape, undoubtedly fudged over by optimistic marks.

Banks NPAs to total loans

Source: IMF, Boombust research and analytics

Euro banks remain weak as compared to their US counterparts

Health of European banks is weaker when compared to US banks. European banks are highly leveraged compared to their US counterparts (11.1x versus 4.1x) and are undercapitalized with core capital ratio of 6.5x vs. 8.5x. Also, the profitability of European banks is lower with net interest margin of 1.2% compared with 3.3%. However, non-performing loans-to-total loans for European banks are slightly better off when compared to US with NPL/loans at 4.9% vs. 5.6%. Nonetheless, considering the backdrop of high exposure to sovereign debt in Euro peripheral countries, we could see substantial write-downs for Euro banks AFS and HTM portfolio, which would more than offsets the relative strength of loan portfolio.

With all due respect to that NassimTaleb dude who popularized the term "Black Swasn", Black Swan events are both overrated and the term is sloppily bandied about by those who may not be putting the requisite thought into just how utilitarian the knowledge of Black Swans actually are. Since you can't accurately predict, nor back test against, nor adequately hedge against such events, exactly what good is a Black Swan discussion. Well, I can answer that question. Black Swan events do maximum damage when the economic cycle is at its weakest. In Reggie Middleton's Economic Circle of Life (think the Lion King) it is the right portion of the circle in which Black Swan events do the most damage.

Actually, it is not the Black Swan events themselves that do the damage but said event do serve as the catalyst that either bust a bubble that was waiting to pop anyway, or break a structure that was hobbling along on one leg as it was - where we happen to be now in many places of the developed world - sans rampant propaganda, misinformation and disinformation from less than disinterested sources.

I have always been of the contention that the 2008 market crash was cut short by the global machinations of a cadre of central bankers intent on somehow rewriting the rules of economics, investment physics and global finance. They became the buyers of last resort, then consequently the buyers of only resort while at the same time flooding the world with liquidity and guarantees. These central bankers and the countries they allegedly strive to serve took on the debt and nigh worthless assets of the private sector who threw prudence through the window during the "Peak" phase of the circle of economic life, and engaged in rampant speculation. Click to enlarge to print quality...

My condolences truly go out to the people of Japan. A massive earthquake, a horrifyingly destructive tsunami, and then multiple nuclear emergencies and radiation poisoning is more distress than any nation had had to endure in such a short period of time in recent history. I am reticent to discuss the ramifications of such, alas that is the crux of the analysis of BoomBustBlog. I have noticed that many professional investors are detached from the real world causes and consequences of volatility and large swings in the markets. In a way, I can sort of understand. It's like playing a video game. All you are doing is pushing buttons in reactions to changing pixels on a glowing screen. Unfortunately, the reality of the matter is sometimes much more than that. Thus, as we go on to illustrate what I see will probably come out of this situation, let’s keep in mind that real people are getting hurt to very significant extent. Real children, real families, real grandparents...

What could the ruler of Egypt's turmoils possible have to do with the need to takeover even more banks in western Europe and the potential default of several members of the PIIGS group? Read on, my dear friend...

I received an impressive response from my earlier description of the potential for contagion as a result of the Egyptian uprising. It is very engaging to simply fathom the practical melding of the minds of financial analysts, political analysts and global macro-economists. Unfortunately, this is not common practice. As a matter of fact, it is apparently never done in the analysis & research commonly proffered by the brokerage houses and the mainstream media. The practical applications of such has demonstrably superior predictive power over the application of any of the single approaches. For those who have not followed me over the years or somehow feel that an individual or small group cannot outperform the glorious houses for brokerage of "The Street", I urge you to look into who I am and to compare my performance to that of the street's best and brightest over the last few years . I attempted to demonstrate the predictive powers and effectiveness of looking for deeper understanding outside of one's core discipline by illustrating to my readers how our Sovereign Contagion Model predicted a roughly 40% chance of eruption in the Middle East, reference Egypt’s Social Unrest As A Pan-European Economic and Financial Contagion? It Can Happen!!!: